Review of Hemel and Kamin’s The False Promise of Presidential Indexation

In The False Promise of Presidential Indexation, which was recently published in the Yale Journal of Regulation, Professors Daniel Hemel and David Kamin have written an important article that considers whether the executive branch has the power to index capital gains for inflation.  In addition to critiquing the measure as a matter of policy, the authors make a persuasive case that Treasury, absent additional legislation, does not have the authority on its own to index capital gains.

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The article raises the question as to which institutional actor in our government should be responsible for generating a change in law that would have a major impact on both the fisc and the tax system.  This question periodically appears in tax administration; longtime readers of the blog may connect this to other issues; for example, in Loving v IRS a DC district court opinion affirmed by the DC Circuit held that without explicit Congressional authority the IRS could not administratively require hundreds of thousands of previously unlicensed preparers to take a competency test and be responsible for continuing education requirements. 

The article provides current and historical context for indexing capital gains, including a 2018 statement by President Trump that he is “thinking about it very strongly” and a discussion of the last time that there seemed to be serious executive consideration of this proposal, in the waning days of the first Bush administration.  The idea seems to be gaining momentum, as  reports from this summer indicate that President Trump has put this issue on the front burner.

The issue of capital gains indexing is really an issue of basis indexing, an issue that would apply to both capital assets and ordinary assets. Since as the authors point out over 98% of the gain reported was on capital assets (2015 figures), the shorthand way to refer to this issue is on the power to index capital gains. The technical issue turns on whether Treasury could index basis for inflation through regulations. 

The authors discuss why at the time of the proposal’s earlier consideration in the 1990’s  there was general (though not uniform) consensus that Treasury did not have the authority to unilaterally index basis for inflation, including legal opinions from Treasury’s General Counsel and the Justice Department’s Office of Legal Counsel (OLC). As I gear up again to teach basic tax for the fall semester, as I tell my students at Villanova, it is crucial to start with the Internal Revenue Code when thinking about this issue. Section 1012(a) (first enacted as part of the Revenue Act of 1918), says that “[t]he basis of property shall be the cost of such property.” 

The article (starting at page 707) nicely summarizes the main reasons why in 1992 the OLC concluded that “cost” was not ambiguous, looking at its dictionary definition, early Treasury practice, court decisions, and other IRC provisions. Absent finding any ambiguity in the term cost, OLC concluded that cost meant the price paid for an item, and Treasury could not on its own change the meaning of it by regulation.

Hemel and Kamin’s article then discusses developments since the first Bush presidency, including case law outside tax that some proponents have suggested supports finding that cost is indeed an ambiguous term, general administrative law developments, and the tax law’s place within administrative law.  

As to general administrative law, the authors persuasively argue that developments since the early 1990’s make it even harder to support a regulation based capital gains indexing. A key part of the discussion is the authors’ discussion of the “major questions” doctrine, where a number of Supreme Court decisions deny Chevron deference to issues that have deep economic and social significance in the absence of clear Congressional direction to agencies. As the authors note, 

[t]he advent of the major questions doctrine is the most significant post-1992 doctrinal development bearing upon the legality of the presidential indexation proposal.  And it does not bode well for the idea. While the exact boundaries of the major questions doctrine remain unclear, there are compelling arguments that the decision to index basis for inflation or not should qualify as a major question.

As support for this type of change being considered within the major questions doctrine, the authors point to estimates that peg the cost of indexing to be in the magnitude of $10-20 billion a year. They also discuss Supreme Court cases warning against reading delegation into cryptic legislative language:

As Justice Scalia wrote for the Court in Whitman v. American Trucking Association, citing to both MCIand Brown &Williamson: “Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms . . . . [I]t does not, one might say, hide elephants in mouseholes.” And as we have emphasized, indexing basis for inflation would indeed be an elephant.

Drilling down deeper, the authors discuss general Chevron developments and the subtle but important difference in now Justice Kavanaugh’s take on the major questions doctrine-developments that they argue make the case for indexing even weaker. While now Justice Kavanaugh (who authored the DC Circuit Loving opinion, which in part relied on the major case doctrine as justification for concluding that IRS acted outside its authority in its efforts to require mandatory testing and education for unlicensed preparers) is just one member of the Court, Hemel and Kamin also discuss the general discomfort that many of the justices feel for Chevron, including their take that the current “judicial zeitgeist…is decidedly anti-Chevron.”

The authors also address somewhat more difficult questions when they consider whether any party would have standing to challenge regulations. After all, the regulations appear to only help taxpayers, and as the authors note, scholars such as Larry Zelenak considering the issue in the 1990’s felt that without there being a disadvantaged taxpayer, it would be difficult to find a party with standing to challenge the regulations. The authors again look to post 1990’s developments to sidestep the need for individual taxpayer harm, including the possibility that Congress or states could have standing to sue. In addition, the authors creatively argue that indexing would harm some, including brokers, who would bear additional costs to comply with reporting obligations, and taxpayers subject to the charitable deduction cap in Section 170.

Conclusion

The Hemel and Kamin article provides important legal context on this issue. If the Trump administration moves forward with the idea, this article will be required reading for those interested in and likely litigating the issue. Even if the Trump Administration declines to move forward with this idea, given current dysfunction in Washington and the strained relations between the branches, I suspect that there will be even greater temptation to use the IRS to sidestep Congress to achieve policy objectives that have at best a tenuous link to the statutory language. As such, the legal issues Hemel and Kamin discuss are generally important for tax administration, and will likely resurface even when this particular debate goes away, or perhaps hibernates for another generation to consider and likely discount.

Ninth Circuit Holds Reg. Validly Overrules Case Law; Disallows Parol Evidence of Timely Mailing

In Baldwin v. United States, 2019 U.S. App. LEXIS 11036 (9th Cir. April 16, 2019), in a case of first impression in the appellate courts, the Ninth Circuit has held that a 2011 regulation under section 7502 is valid under the deference rules of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984), and Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005), and therefore it invalidates all prior case law in some Circuits (including the Ninth) holding that the common law mailbox rule can be used to prove the IRS’ timely receipt of a document by parol evidence. The Circuit reversed the district court and directed it to dismiss the case because the only evidence offered of timely mailing of a Form 1040X refund claim was the testimony of the Baldwins’ employees that they remember timely posting the envelope containing the claim by regular mail months before the claim was due – evidence that is only relevant if the common law mailbox rule still exists in the tax law. I blogged on Baldwin before the oral argument here.

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Facts

Baldwin is a tax refund suit. There, the taxpayers reported a loss on their 2007 income tax return, filed on or before the extended due date of October 15, 2008. They wished to file an amended return for 2005, carrying back the 2007 loss to generate a refund in 2005. Under section 6511(d), this had to be done by filing the amended return within three years of the due date of the return generating the loss – i.e., by October 15, 2011. The taxpayers introduced testimony of their employees that the employees mailed the 2005 amended return by regular mail on June 21, 2011 from a Hartford Post Office to the Andover Service Center. But, the IRS claimed it never received the Form 1040X.

The California district court followed Anderson v. United States, 966 F.2d 487 (9th Cir. 1992), in which the Ninth Circuit had held that the enactment of section 7502 in 1954 did not eliminate the common law mailbox rule and still allowed taxpayers to prove by parol evidence that a document not sent by registered or certified mail or a designated private delivery service was actually mailed and so was presumed to have been received by the IRS prior to the due date. The district court credited the testimony of the employees and held that the refund claim was timely filed. The court later awarded the taxpayers a refund of roughly $167,000 and litigation costs of roughly $25,000.

The DOJ appealed the loss to the Ninth Circuit, where it argued that the suit should have been dismissed because the refund claim was not timely filed. The DOJ argued that in August 2011, the IRS adopted a regulation intended to overrule some Circuit court opinions (including Anderson) that had held that the common law mailbox rule still survived the enactment of section 7502. At least one other Circuit had agreed with Anderson; Estate of Wood v. Commissioner, 909 F.2d 1155 (8th Cir. 1990); but several other Circuits had disagreed and held that the common law mailbox rule did not survive the enactment of section 7502. See Miller v. United States, 784 F.2d 728 (6th Cir. 1986)Deutsch v. Commissioner, 599 F.2d 44 (2d Cir. 1979)See also Sorrentino v. Internal Revenue Service, 383 F.3d 1187 (10th Cir. 2004) (carving out a middle position).

As amended by T.D. 9543 at 76 Fed. Reg. 52,561-52,563 (Aug. 23, 2011), Reg. § 301.7502-1(e)(2)(i) provides, in relevant part:

Other than direct proof of actual delivery, proof of proper use of registered or certified mail, and proof of proper use of a duly designated [private delivery service] . . . are the exclusive means to establish prima facie evidence of delivery of a document to the agency, officer, or office with which the document is required to be filed. No other evidence of a postmark or of mailing will be prima facie evidence of delivery or raise a presumption that the document was delivered.

Ninth Circuit Opinion

The Ninth Circuit began its analysis with a little history: Prior to 1954, there was no timely-mailing-is-timely-filing provision in the Internal Revenue Code. That meant that the only way to timely file a document was for it to arrive at the IRS on or before the due date. At common law, there is a presumption that a properly-mailed envelope will arrive in the ordinary time for mail to go between its origin and destination. At common law, a party could bring in any evidence (including testimony) to show that the envelope likely arrived at the IRS on or before the due date.

In 1954, Congress added section 7502 to the Code. We all think of it as a provision that allows a mailing made on or before the due date to be treated as timely filed, whether or not the IRS receives the document on, before, or after the due date. But, that is not an accurate summary of the provision. In fact, subsection (a) provides, in general, that if a document is delivered to the IRS by the United States mail after the due date, then the date of the United States postmark on the envelope is deemed to be the date of delivery (i.e., filing). Other rules extend the benefits of subsection (a) to designated private delivery services and electronic filing, but only pursuant to regulations. However, subsection (c) also includes a presumption of delivery that applies in the case of use of certified or registered mail: If an envelope is sent certified or registered mail, then (1) the certification or registration is prima facie evidence that the envelope was delivered to the place to which it was addressed and (2) the date of registration or certification is deemed the date of the postmark for purposes of subsection (a).

In Anderson, the Ninth Circuit had held that subsection (c)’s presumption of delivery language (and the regulations thereunder) did not supplant the common law way to prove delivery on or before the due date. Rather, subsection (c) provided only a safe harbor for proof of delivery if certified or registered mail was used. Where ordinary mail was used, there was no statutory provision presuming or denying proof of delivery, so the common law mailbox rule could still operate to allow proof of timely mailing by any evidence.

In Baldwin, the Ninth Circuit noted that under Chevron Step 2, a court must defer to an agency’s interpretation in a regulation if that interpretation is one of the reasonable ways an ambiguous statute could be interpreted. And in Brand X, the Supreme Court held that, unless an appellate court opinion had said that the statute was unambiguous (and therefore Chevron Step 1 would deny any regulatory input), an agency could issue valid regulations overruling that appellate precedent.

In the case of the 2011 regulation under section 7502, the Ninth Circuit in Baldwin held that an interpretation that section 7502 completely supplanted the common law mailbox rule was one of the reasonable interpretations of that statute and that the Ninth Circuit had not, in its Anderson opinion, rested its holding on the unambiguous nature of section 7502’s language. Therefore, under Chevron and Brand X, the regulation barring the use of the common law mailbox rule was valid.

The taxpayers had two arguments that the Ninth Circuit quickly dismissed:

First, the taxpayers argued that there is a rule of construction that makes repeal of common law rules by statute not to be easily implied. With respect to this argument, the Ninth Circuit noted a contrary rule of construction (one that other Circuits had relied on) that when a statute speaks on an issue and makes an exception, that statutory exception eliminates all nonstatutory exceptions. The Ninth Circuit held that the subsection (c) rules presuming delivery in the case of certified or registered mail could benefit by the latter interpretive rule. Thus, these countervailing statutory rules of construction could lead to two different reasonable interpretations of the statute.

Second, the taxpayers argued that the regulation was improperly being applied retroactively, since they had claimed that they mailed the envelope in June 2011, but the regulation was only adopted in August 2011. But, the Ninth Circuit pointed out that the regulation was effective for all documents mailed after September 21, 2004 (the date the regulation was first proposed), and the court did not find that such retroactive effective date violated section 7805(b)(1)(B), which allows the IRS to make its regulations retroactive to the date they are first proposed.

Observations

Several Supreme Court Justices have recently criticized Chevron and Brand X. It is interesting that Judge Watford, who wrote the Baldwin opinion, only predicated the panel’s ruling for the IRS on the basis of reliance on those two opinions. What, then, happens if Chevron and Brand X are overruled? Will the Ninth Circuit’s precedent then revert to Anderson, which allows use of the common law mailbox rule?

Judge Watford also seems to be deliberately vague in his opinion as to the ground on which the district court should dismiss the case on remand. He does not say the dismissal should be for lack of jurisdiction (FRCP 12(b)(1)) or for failure to state a claim (FRCP 12(b)(6)). It would not much matter in this case whether the section 6511 filing deadline were jurisdictional or not, but it might matter in a future case (e.g., one where there was an argument for waiver, forfeiture, or estoppel, but not equitable tolling (see United States v. Brockamp, 519 U.S. 347 (1997) (holding the deadline not subject to equitable tolling, but not discussing whether the deadline is jurisdictional)). Indeed, Judge Watford’s Baldwin opinion really relies on section 7422(a), which requires the filing of a refund claim before a refund suit may be maintained. The opinion states that section 7422(a) also requires a timely claim. In fact, Judge Watford only writes:

The Baldwins then brought this action against the United States in the district court. Although the doctrine of sovereign immunity would ordinarily bar such a suit, the United States has waived its immunity from suit by allowing a taxpayer to file a civil action to recover “any internal-revenue tax alleged to have been erroneously or illegally assessed or collected.” 28 U.S.C. § 1346(a)(1). Under the Internal Revenue Code (IRC), though, no such action may be maintained in any court “until a claim for refund or credit has been duly filed” with the IRS, in accordance with IRS regulations. 26 U.S.C. § 7422(a); see United States v. Dalm, 494 U.S. 596, 609 (1990). To be “duly filed,” a claim for refund must be filed within the time limit set by law. Yuen v. United States, 825 F.2d 244, 245 (9th Cir. 1987) (per curiam).

Judge Watford is the author of the opinion in Volpicelli v. United States, 777 F.3d 1042 (9th Cir. 2015), which we blogged on here and where I was amicus. In that opinion, he held that the then-9-month filing deadline to bring a wrongful levy suit in district court is not jurisdictional and is subject to equitable tolling under recent Supreme Court case law making filing deadlines now only rarely jurisdictional. Note that his language above from Baldwin does not mention the word “jurisdictional” with regard to section 7422(a)’s requirement. Judge Watford may not be wanting to say that section 7422(a)’s administrative exhaustion requirement is jurisdictional, rather than a nonjurisdictional mandatory claims processing rule possibly subject to waiver, forfeiture, or estoppel. It is true that in Dalm (which he cites only with a “see”), the Supreme Court called the requirements of sections 7422(a) and 6511 jurisdictional with respect to a refund suit, but the reasoning of Dalm does not accord with current Supreme Court case law. In 2016, the Seventh Circuit questioned whether Dalm is still good law, though it did not reach the question, writing:

The Gillespies do not respond to the government’s renewed argument that § 7422(a) is jurisdictional, though we note that the Supreme Court’s most recent discussion of § 7422(a) does not describe it in this manner, see Unites States v. Clintwood Elkhorn Mining Co., 553 U.S. 1, 4-5, 11-12 (2008). And other recent decisions by the Court construe similar prerequisites as claims-processing rules rather than jurisdictional requirements, see, e.g., United States v. Kwai Fun Wong, 135 S. Ct. 1625, 1632-33 (2015) (concluding that administrative exhaustion requirement of Federal Tort Claims Act is not jurisdictional); Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154, 157 (2010) (concluding that Copyright Act’s registration requirement is not jurisdictional); Arbaugh v. Y&H Corp., 546 U.S. 500, 504 (2006) (concluding that statutory minimum of 50 workers for employer to be subject to Title VII of Civil Rights Act of 1964 is not jurisdictional). These developments may cast doubt on the line of cases suggesting that § 7422(a) is jurisdictional. See, e.g., United States v. Dalm, 494 U.S. 596, 601-02 (1990).

Gillespie v. United States, 670 Fed. Appx. 393, 394-395 (7th Cir. 2016) (some citations omitted). It was this passage from Gillespie that the DOJ cited as grounds for its need to file a post-oral argument memorandum of law in Tilden v. Commissioner, 846 F.3d 882 (7th Cir. 2017), arguing that the section 6213(a) Tax Court deficiency petition filing deadline is jurisdictional and not subject to waiver. The DOJ won that argument in that case, but it is currently before the Ninth Circuit on the issues of jurisdictional and equitable tolling in companion cases on which we previously blogged here.

Quick Takes: Altera, Senate Finance Committee Testimony on IRS Reform

I am trying to meet a deadline before a last gasp of summer vacation in California, and I have had a little less time than usual for blogging.  Tax procedure and tax administration developments wait for no one, however, and much has been happening this week. I will briefly discuss and add some links to two major developments: the Altera case and the Senate Finance Committee Subcommittee on Tax and IRS Oversight hearing.

Altera

As I am sure many readers know, the Ninth Circuit reversed the Tax Court in the heavily anticipated case of Altera v Commissioner, a case we have blogged numerous times. The basic holdings in the Ninth Circuit case all involved the broader question as to whether Treasury exceeded “its authority in requiring Altera’s cost-sharing arrangement to include a particular distribution of employee stock compensation costs.”

The Ninth Circuit, in a divided opinion that included now deceased Judge Stephen Reinhardt in the majority, concluded that the Treasury did not. In so doing, it held that Treasury did not violate the APA in its rulemaking, and under Chevron the court deferred to Treasury’s take on the substantive issue of allocation of employee stock compensation costs.

We will have more on this decision in PT. In the meantime, here are some comments on the decision in the blogosgphere:

Dan Shaviro in Start Making Sense trumpets the 9thCircuit getting to the right outcome

Leandra Lederman in The Surly Subgroup, who like Professor Shaviro wrote an amicus arguing for reversal, succinctly summarizes the holding

Jack Townsend, who in his Federal Tax Procedure blog, in addition to linking to his excellent and free tax procedure book offers his take on the case, including his gloss on Chevron and his forecast that if the Supreme Court gets to this one there is a good chance for the Supremes “screwing it up”

Chris Walker at Notice and Comment who expresses unease about the process, especially the aspect of including as part of the majority a judge who passed away prior to the Court’s issuing the opinion

Alan Horowitz at Miller & Chevalier’s Tax Appellate blog, discussing the holding and likely petition for rehearing by the full circuit

Senate Hearing on Tax Administration

The Senate Finance Committee’s Subcommitte on Taxation and IRS Oversight had a hearing yesterday on improving tax administration.

Here is a link to the audio; witnesses, whose written testimony is linked above, were

  • Caroline Bruckner, Managing Director of the Kogod Tax Policy Center at American University ;
  • Phyllis Jo Kubey, Member of the National Association of Enrolled Agents and the IRS Advisory Council ;
  • Nina Olson, the National Taxpayer Advocate ;
  • John Sapp, the current Chair of the Electronic Tax Administration Advisory Committee advising the Internal Revenue Service, and
  • Rebecca Thompson, the Project Director of the Taxpayer Opportunity

Senator Portman’s introductory statement is here—in it he notes the 20thanniversary of the IRS Restructuring and Reform Act, and how he and Senator Cardin recently introduced the Taxpayer First Act(following the House passing its version of legislation).

The National Taxpayer Advocate blogged on the hearing, including her take encouraging “everyone who cares about improving tax administration to watch the hearing and read the testimony submitted.”

Does the Mailbox Rule Survive a 2011 Reg. Under Section 7502?

We welcome back frequest guest blogger Carl Smith who discusses important forthcoming arguments regarding the mailbox rule.  This seemingly simple procedural provision gives rise to its fair share of litigation because it can make or break a case.  The cases that Carl flags are worth watching for those in need of the mailbox rule to preserve the timeliness of a submission.  Keith

 Before section 7502 was added to the Internal Revenue Code in 1954, courts determined the timeliness of various filings required under the Internal Revenue Code under a common law mailbox rule under which, if there was credible extrinsic evidence of timely mailing via the U.S. mails, then a document was presumed to have been delivered (despite denials of receipt), and if the mailing was made before the filing date, the mailing effected a timely filing. Of course, the use of certified or registered mail was excellent proof of timely mailing under the mailbox rule, but testimony about timely use of regular mail could be believed by the court, as well.

Over the years, some Circuits have faced the issue of whether the enactment of the statutory timely-mailing-is-timely-filing provision of section 7502 preempted or supplemented the mailbox rule. Compare Anderson v. United States, 966 F.2d 487 (9thCir. 1992)(mailbox rule still valid); Estate of Wood v. Commissioner, 909 F.2d 1155 (8th Cir. 1990)(same); withMiller v. United States, 784 F.2d 728 (6th Cir. 1986)(mailbox rule preempted by section 7502); Deutsch v. Commissioner, 599 F.2d 44 (2d Cir. 1979)(same). See alsoSorrentino v. Internal Revenue Service, 383 F.3d 1187 (10th Cir. 2004)(carving out a middle position).

In 2011, a Treasury Regulation under section 7502 was amended to specifically provide, in effect, that the common law mailbox rule no longer operated under the Code.  Since then, a few district courts have faced the question of the validity of this regulation.  Two courts have held the regulation valid under the deference rules of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984).  McBrady v. United States, 167 F. Supp. 3d 1012, 1017 (D. Minn. 2016);Jacob v. United States, No. 15-10895, 2016 WL 6441280 at *2 (E.D. Mich. Nov. 1, 2016).  Another district court, in an unpublished opinion in a tax refund suit, followed Andersonand applied the mailbox rule, without discussing the regulation.  Baldwin v. United States, No. 2:15-CV-06004 (C.D. Cal. 2016).

While no court of appeal has yet ruled on the validity of the regulation, on August 31, 2018, the Ninth Circuit will hear oral argument both on the government’s appeal of Baldwinand the taxpayers’ allegedly late appeal from an unrelated Tax Court Collection Due Process (CDP) case.  Both cases squarely present the issue of whether the Ninth Circuit should hold that its Andersonopinion has been superseded by a Treasury regulation abolishing the mailbox rule – a regulation that must be considered valid under Chevrondeference.

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Baldwin

Baldwin is a tax refund suit.  There, the taxpayers reported a loss on their 2007 income tax return, filed on or before the extended due date of October 15, 2008.  They wished to file an amended return for 2005, carrying back the 2007 loss to generate a refund in 2005.  Under section 6511(d), this had to be done by filing the amended return within three years of the due date of the return generating the loss – i.e., by October 15, 2011.  The taxpayers, while living in Connecticut, had properly filed their original 2005 return with the Andover Service Center, but by 2011, original returns of Connecticut residents needed to be filed at the Kansas City Service Center.  In 2011,Reg. § 301.6402-2(a)(2)provided that “a claim for credit or refund must be filed with the service center serving the internal revenue district in which the tax was paid.” That would be Andover.  But, instructions to the 2010 Form 1040X (the one used by the taxpayers) told Connecticut taxpayers to file those forms with Kansas City, where original Forms 1040 for 2010 were now being filed.  (In 2015, the regulation was amended to provide that amended returns should be filed where the forms direct, not where the tax was paid.)

The taxpayers introduced testimony by one of their employees that the employee mailed the 2005 amended return by regular mail on June 21, 2011 from a Hartford Post Office to the Andover Service Center.  But, the IRS claimed it never received the Form 1040X prior to October 15, 2011, and that the filing was in the wrong Service Center.

The district court credited the testimony of mailing, citing the Anderson Ninth Circuit opinion that allowed for the common law mailbox rule to apply.  The Baldwincourt’s opinion does not mention the August 23, 2011 amendment to the regulation under section 7502 (quoted below) that purports to preempt use of the mailbox rule.  The court went on to find that, given the conflict between the regulation under section 6402 and the form instructions, a taxpayer was then “simply required . . . [to] mail his amended return in such a way that it would, as a matter of course, be delivered to the proper service center to handle the claim within the statutory period.”  Finding that this was done here, the court held the refund claim timely filed.  The Court also observed:  “The fact that the IRS routinely forwards incorrectly addressed refund claims as a matter of course also suggests that the IRS does not consider an address problem to be fatal to a refund claim.”

Then, the Baldwin court, over the government’s objections, found that a net operating loss had been incurred in 2007 and could be carried back to 2005, resulting in a refund due the taxpayers of $167,663.  To add insult to injury, the court also held that the government’s litigating position in the case, after a certain point, was not substantially justified, so the court imposed litigation costs payable to the taxpayers under section 7430 of $25,515.

The government appealed, arguing not only that there was no valid net operating loss in 2007 to be carried back (and so the litigation costs, as well, should not have been imposed), but that the district court lacked jurisdiction because the refund claim was not filed within the time set forth in section 6511(d).

Waltner

The Waltners are a couple who have been to the Tax Court may times, and even have been sanctioned under section 6673for making frivolous arguments (even their attorney has sometimes been sanctioned thereunder).  Their Tax Court case at Docket No. 8726-11L involved an appeal by them of multiple CDP notices of determination involving multiple years of income tax and frivolous return penalties under section 6702.  In an unpublished orderon April 21, 2015, Judge Foley granted the IRS’ motion for summary judgment with respect to some of the notices of determination, but not as to all notices.  The parties later reached a settlement on the other notices, which was embodied in a stipulated decision entered by the court on January 21, 2016.  Under section 7483, this started a 90-day window in which the Waltners had to file any notice of appeal.

An August 9, 2016 unpublished order of then-Chief Judge Marvel describes what happened next:

On August 4, 2016, petitioners electronically filed a Statement Letter to the Clerk of the U.S. Tax Court (With Ex.).  Among other things, in that Statement petitioners assert that: (1) on April 15, 2016, petitioners sent by regular U.S. mail to the Tax Court a notice of appeal in this case to the U.S. Court of Appeals for the Ninth Circuit; and (2) that notice of appeal (a) either may have been lost by the U.S. Postal Service, or (b) may have been lost after delivery to the Tax Court.  Attached to the Declaration of Sarah V. Waltner as Exhibit A, is a copy of Petitioners’ Notice of Appeal to the Court of Appeals for the Ninth Circuit.  Because this case is closed, petitioners’ Statement Letter to the Clerk of the U.S. Tax Court (With Ex.) may not be filed.

On August 15, 2016, the Waltners then admittedly filed a proper notice of appeal with the Tax Court.   But, the Ninth Circuit questioned whether the appeal was timely and sought briefing on this issue.  The DOJ argued that the appellate court lacked jurisdiction because the notice of appeal was untimely.

DOJ Argument

 Here are the links to the Baldwin Ninth Circuit appellant’s brief, appellees’ brief, and the reply brief.  Also, here are the links to the Waltner Ninth Circuit appellants’ brief, appellee’s brief, and the reply brief in the Ninth Circuit.  Although the two cases are not consolidated with each other, they have been scheduled to be argued one after the other before the Ninth Circuit in Pasadena on August 31, 2018.  And the DOJ briefs are clearly coordinated in their argument.

The DOJ arguments are predicated on the Treasury’s section 7502 regulation, Chevron, and Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005).

As amended by 76 Fed. Reg. 52561-01 (Aug. 23, 2011), Reg. § 301.7502-1(e)(2)(i)provides, in relevant part:

Other than direct proof of actual delivery, proof of proper use of registered or certified mail, and proof of proper use of a duly designated [private delivery service] . . . are the exclusive means to establish prima facie evidence of delivery of a document to the agency, officer, or office with which the document is required to be filed.  No other evidence of a postmark or of mailing will be prima facie evidence of delivery or raise a presumption that the document was delivered.

The DOJ argues that section 7502, when enacted (and still today) is ambiguous as to whether it preempts the common law mailbox rule.  The DOJ contends that there is thus a gap to fill, which, under Chevron, can be filled by a reasonable regulation. The Circuit split over whether the mailbox rule has been preempted is evidence of two reasonable interpretations of section 7502.  The regulation is valid because it chooses one of those two reasonable interpretations.

In Brand X, the Supreme Court held that Chevron deference must even apply to a regulation that takes a position that has been rejected by a court, so long as the court opinion did not state that it found the statute unambiguous.  If the statute was unambiguous, then there can be no gap under ChevronStep One to fill.  PT readers may remember the extensive discussion of Brand X in the section 6501(e) Treasury Regulation case of United States v. Home Concrete & Supply, LLC, 566 U.S. 478 (2012).

The DOJ argues that Anderson did not describe its interpretation of section 7502 to still allow the mailbox rule as one required by an unambiguous statute.  Accordingly, under Brand X, the 2011 amendment to the section 7502 regulation is entitled to Chevron deference, in spite of Anderson.

We’ll see in Baldwin and Waltner if the government can effectively overrule Anderson by its regulation.

Observations

I will not needlessly extend this post by explaining my beef with the DOJ’s other arguments that compliance with the filing deadlines for refund claims under section 6511 and for notices of appeal under section 7483 are “jurisdictional” conditions of the courts.  I don’t think that either deadline is jurisdictional under current Supreme Court case law that makes filing deadlines now only rarely jurisdictional.  And, sadly, none of the taxpayers in these two cases made an argument that the filing deadlines are not jurisdictional – probably because it makes no difference in the outcome of their cases whether the filing deadlines are jurisdictional or not.  The taxpayers are not arguing for equitable tolling, just the mailbox rule (which is not an equitable doctrine that would be precluded by a jurisdictional deadline).  I only regret that I did not learn of either of these two cases earlier, when I could have filed amicus briefs raising the issue of whether the two filings deadlines are really jurisdictional.  At least the courts, then, might have noted that it is a debatable question whether these two filing deadlines are jurisdictional.

9th Circuit Opines on TEFRA Small Partnership Exception’s Application to Disregarded Entities and Punts on Issue of Deference Given to Revenue Rulings

Today Treasury re-released regulations under the new partnership audit regime, and that is a reminder that TEFRA is on its way out, putting pressure on me and my Saltzman/Book colleagues to finish our new chapter on partnership audits. Despite the new regime, courts, taxpayers and IRS still wrestle with TEFRA, which, given its complexity, will still produce developments for the blog and the treatise for the foreseeable future. Those developments include technical TEFRA issues, as here, but also broader issues of importance to tax procedure, including the degree of deference that courts should give to revenue rulings and when disregarded entities under the check the box regulations are not to be disregarded for all purposes.

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Last week the 9th Circuit in Seaview Trading v Commissioner considered one nook and cranny of TEFRA, the Section 6321 small partnership exception that applies when the partnership has “10 or fewer partners each of whom is an individual . . . , a C corporation, or an estate of a deceased partner.”

In Seaview, the father and son partners each held their interest in a partnership via single member LLCs that were organized under Delaware law. IRS audited the partnership and under TEFRA issued a final partnership administrative adjustment (FPAA) disallowing partnership losses relating to the 2001 year. The statute of limitations had long passed on the father and son’s individual 2001 tax returns if the TEFRA rules were not applicable. The son, on behalf of the partnership, filed a petition in Tax Court claiming that the FPAA was invalid because the partnership was exempt from TEFRA due to its qualifying for the small partnership exception. The Tax Court disagreed, and the Ninth Circuit, on appeal, affirmed the Tax Court. In so doing, it expounded on the relationship between State and Federal law and the deference given to revenue rulings.

In this brief post I will explain the issue and summarize the appellate court’s opinion.

As most readers know, the check the box regulations under Section 7701 disregard a solely owned LLC unless the owner elects otherwise. Regulations under Section 6321 provide that the small partnership TEFRA exception “does not apply to a partnership for a taxable year if any partner in the partnership during that taxable year is a pass-thru partner as defined in section 6231(a)(9).” TEFRA, at Section 6321(a)(9), defines a pass-thru partner as any “partnership, estate, trust, S corporation, nominee, or other similar person through whom other persons hold an interest in the partnership.” Section 6321(a)(9) predates the LLC and like entity explosion of the late 20th century, and there are no Treasury regulations that define LLCs and the like as a pass-thru partner.

The partnership in Seaview argued that under the check the box regulations, the LLCs that held the partnership were treated as sole proprietorships of their respective individual owners, and that consequently they could not constitute pass-thru partners within the meaning of the TEFRA regulations.

Despite the absence of regulations that address the issue of how interests held through single member LLCS are treated under the small partnership exception, the IRS, in Revenue Ruling 2004-88, specifically considered that issue. The revenue ruling held that a partnership whose interest is held through a disregarded entity ineligible for the small partnership exemption because a disregarded entity is a pass-thru entity.

In reaching its conclusion that the small partnership exception did not apply, the 9th Circuit addressed how much deference it should give to the IRS’s revenue ruling. The opinion notes that there is some uncertainty on the degree of deference to informal agency positions like revenue rulings. The court explained that in Omohundro v. United States the 9th circuit has generally given Skidmore deference to them. On the other hand, it noted that under the 2002 Schuetz v. Banc One Mortgage Corp., the 9th Circuit had given greater Chevron deference to an informal HUD agency position, and that there is some tension between the circuit’s approach in Schuetz and its approach in Omohundro.

It avoided having to resolve the tension between Omohundro and Schuetz by finding that the Service position in the revenue ruling was correct even when applying the less deferential Skidmore standard. The Skidmore test essentially means that courts defer to the position if it finds it persuasive. As the opinion describes, factors that courts have considered in analyzing whether a position is persuasive include the position’s thoroughness, agency consistency in analyzing an issue and the formality associated with the guidance.

The taxpayers in Seaview essentially hung their hat on the revenue ruling’s rather brief discussion of the sole member LLC issue, but the court nonetheless found the ruling persuasive and also consistent with other cases and less formal IRS counsel opinions that likewise considered the application of the small partnership exception to disregarded entities.

For those few readers with an appetite for TEFRA complexity, I recommend the opinion, but in a nutshell the court agreed with the Service approach that looked first to how the statute’s language did not reflect a Congressional directive to limit the exception to only listed entities. As the opinion discussed, Section 6321(a)(9) defines a pass thru partner as a “partnership[s], estate[s], trust[s], S corporation[s], nominee[s] or [an]other similar person through whom other persons hold an interest in the partnership.” Noting that the statute itself contemplates its application beyond the “specific enumerated forms” the question turns on “whether a single- member LLC constitutes a “similar person” in respect to the enumerated entities.”

The opinion states that “Ruling 2004-88 holds that the requisite similarity exists when ‘legal title to a partnership interest is held in the name of a person other than the ultimate owner.’ ” That line drawing, in the 9th Circuit view, was persuasive, and the revenue ruling had in coming up with the approach cited to and briefly discussed cases that supported the IRS position, including one case where a custodian for minor children was not a pass thru partner because he did not have legal title and another case where a grantor trust was a pass thru partner because it did hold legal title.

One other point, the relationship between state and federal law, is worth highlighting. The taxpayers gamely argued that the IRS view impermissibly elevated state law considerations to determine a federal tax outcome. The court disagreed:

But the issue here is not whether the IRS may use state-law entity classifications to determine federal taxes. Rather, the question is whether an LLC’s federal classification for federal tax purposes negates the factual circumstance in which the owner of a partnership holds title through a separate entity. In other words, state law is relevant to Ruling 2004-88’s analysis only insofar as state law determines whether an entity bears the requisite similarity to the entities expressly enumerated in § 6231(a)(9)—that is, whether an entity holds legal title to a partnership interest such that title is not held by the interest’s owner.

Conclusion

The Bipartisan Budget Act (BBA) new rules for partnership audits begin for returns filed for partnership tax years beginning in 2018. As partners and advisors navigate the uncertain waters of a new BBA partnership audit regime, TEFRA and its complexity will be with us for some time.

The BBA regime has opt out procedures for partnerships that have 100 or fewer qualifying partners. Essentially the statute states that all partners must be individuals,  C corporations, or any foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner. While silent on the treatment of disregarded entities, the BBA statute also states that Treasury and IRS by “regulation or other guidance” can prescribe rules similar to the rules that define the category of qualifying partners. 

Proposed Treasury regulations under the BBA were in limbo but earlier today Treasury re-released regulations that provide guidance for the new regime. The proposed BBA regulations specifically address disregarded entities. Despite comments in response to an earlier notice asking Treasury to allow disregarded entities to be treated as qualifying partners, the proposed regulations do not include disregarded entities as qualifying partners and the preamble specifically states that Treasury declined to do so because “the IRS will face additional administrative burden in examining those structures and partners under the deficiency rules.”

The upshot is that for under both TEFRA and likely BBA disregarded entities holding interests in a partnership mean that the general partnership audit rules will apply.

 

 

 

 

Good Fortune (for the IRS)

This week the Tax Court in Good Fortune Shipping v Commissioner,148 TC No. 10 upheld regulations relating to the exemption of income from the international operation of ships. Taxpayers are frequently teeing up issues relating to the validity of regulations, and this opinion is an important victory for the government. I will briefly describe the case and the way the Tax Court resolved the dispute.

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The statutory scheme under Section 883 (wildly simplified) is that gross income attributable to international shipping activities is exempt from US tax if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. In Good Fortune the owners of the shipping company were in fact residents of a country that did grant a similar exemption, but the shareholders held the stock in bearer form rather than in registered form. The statutory scheme tied the exemption to shares “owned by individuals” of a reciprocating foreign country; the regulations additionally restricted the benefit to shares that were owned in a certain way, and in particular excluded from the possible statutory exclusion scheme shares that were owned in bearer rather than registered form.

Bearer ownership and transferability is generally evidenced by physical delivery; registered form ownership ties ownership to a name that is registered with the corporation or its agent. US tax law has generally frowned on conveying benefits that are dependent on residence of ownership when shares or securities are held in bearer form for the obvious reason that it is easy to circumvent rules that are meant to tie exclusions or reduced withholdings on beneficial ownership in a particular jurisdiction when ownership can be conveyed just by possessing the security. Bearer form ownership promotes privacy, which is a value that tax agencies weigh quite differently than taxpayers.

In Good Fortune, in upholding regulations that essentially stated that bearer shares of a foreign corporation may not be taken into account in establishing the ownership of the stock of the foreign corporation, the Tax Court, applying the two-step Chevron analysis, leaned heavily on Mayo in finding that Congress had not spoken directly on the issue (step 1) and ultimately concluded that the regulations in place for the year in question were a permissible construction of the statute (step 2).

In finding that the precision needed was lacking in Step 1 the opinion emphasized that there was a legislative gap in how to prove ownership:

The words “owned by individuals” in section 883(c)(1) do not, as petitioner appears to acknowledge, explain or otherwise address how to establish ownership by individuals for purposes of section 883(c)(1), let alone how to establish ownership where the shares of the foreign corporation are owned in bearer form. The dictionary definitions of the word “own” on which petitioner relies which petitioner claims are unambiguous definitions, do not address the problem under section 883(c) of determining how to establish ownership by individuals for purposes of section 883(c)(1) that the Internal Revenue Service (IRS) confronts when it examines a return of a foreign corporation seeking the benefits of section 883(a)(1) for a prior taxable year

Upon reaching Step 2, the opinion looked to legislative history to 1986 statutory changes that tied the reciprocal exemption to corporate ownership rather than just the location of where the ship was registered:

A foreign corporation’s entitlement under section 883(a)(1) to exclude certain income from gross income and exempt that income from U.S. tax no longer was based solely upon the country in which the foreign corporation’s vessel was registered or documented. Instead, Congress added in its amendment of section 883 in the 1986 Act a second hurdle to that favorable treatment by enacting section 883(c) in order to curb abuse by residents of certain foreign countries who owned stock in a foreign corporation that was seeking the benefits of section 883(a)(1) where those foreign countries did not provide an equivalent exemption to U.S. corporations.

With that context the opinion discussed how bearer shares, which tie ownership to physical delivery, “make it virtually impossible to know who the actual shareholders or owners of a corporation are because the only proof of ownership is physical possession at a particular point in time of the paper bearer share certificate.” The absence of a registry contributes to ownership anonymity. As such, it was a short step for the court to conclude that the regs passed muster under Step 2:

We conclude that the bearer share regulations do not contravene section 883(c)(1) but are a reasonable construction of that section which provides the IRS with the appropriate tools needed to enforce section 883. The bearer share regulations provide certainty and resolve the difficult problems of proof associated with establishing ownership of bearer shares, especially for prior taxable years. In not allowing bearer shares to be taken into account in establishing the ownership of the stock of a foreign corporation for purposes of determining whether the foreign corporation is described in section 883(c)(1) and thus whether it is entitled to the benefits of section 883(a)(1), the bearer share regulations set forth a sensible approach to effecting the intent of Congress in enacting section 883(c)(1) to ensure that abuse will not occur which will result in certain types of shipping transportation income described in section 883(a)(1) not being taxed.

Good Fortune shows how in the absence of statutory detail on implementation, agencies have considerable discretion in promulgating rules, especially true when the rules relate to exemptions, which as the Tax Court noted here, are to be interpreted narrowly.

Dean Zerbe Adds Insights to Whistleblower “Collected Proceeds” Tax Court Case

On August 4th, I wrote about the Tax Court’s second holding in Whistleblower 21276-13W v. Commissioner, and how the Court held that “collected proceeds” included criminal fines and civil forfeitures.   That post can be found here.  In the post, we noted that Dean Zerbe was the attorney on the prior case who successfully obtained the whistleblower award, and we assumed he was the lead attorney on this case, but the attorney of record was sealed.

Dean was one of the primary architects of the whistleblower statute, and one of the leading practitioners in this area, so it is not surprising to see him attached to these important cases.  Dean reached out to me last week and confirmed he was the lead attorney on this case also.  He also provided some feedback on the post and some of the issues we highlighted.  I’ve recreated some of Dean’s insightful comments below.  It probably goes without saying, any errors and coarse language are assuredly mine .

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I will not recreate my prior post, but will add a few excerpts to provide context to Dean’s comments.  The key issue was:

Under Section 7623(b), certain whistleblowers are entitled to mandatory awards if certain requirements are met.  That amount can be between 15% and 30% of the “collected proceeds” under (b)(1), which has a parenthetical indicating that is “(including penalties, interest, additions to tax, and additional amounts),” and the sentence further states these amounts can be “resulting from the action (including any related actions) or from any settlement in response to such action.”

As stated above, the Service took the position collected proceeds did not include criminal penalties and civil forfeitures.  The Service based this on the claim that Section 7623 should only apply to proceeds assessed and collected under the federal tax laws found in Title 26 of the United States Code.  As the fines and forfeitures here were imposed under Chapter 18, they could then not be “collected proceeds” subject to the statute; unlike the restitution, which as per 2010 law can be assessed and collected in the same manner as tax.

The Court held “internal revenue laws” were not simply those under Title 26, and included the fines and forfeitures.  This implicates FBAR penalties also, although not explicitly stated in the holding.  Dean’s thoughts on the holding generally were as follows:

I read  the case as the Court seeking to get rid of any shadows or dark corners about what is included in “collected proceeds” and not wanting to see this litigated again and again (there are a lot of these cases in the pipeline).  [My impression] is the Tax Court will not engage in hair splitting.  See page 26, “In sum, we herein hold that the phrase “collected proceeds” is sweeping in scope and is not limited to amounts assessed and collected under Title 26.”    And again on page 29, “We have already explained that ‘collected proceeds’ is a broadly defined term:  It encompasses ‘the total amount brought in’ by the Government.”   And then again, of course, the language in first paragraph of page 32.  There is nowhere to hide with those statements.

I think one of the more interesting points in this opinion (which deserves a lot of rereading) is on page 30, where the Court correctly states that the “forfeitures resulted from an administrative action with respect to the laundering of proceeds, which in turn, arose from a conspiracy to violate Section 7601 and 7206…”   Encompassing, properly, a broad linkage and again speaks to FBAR.

As to FBAR, Dean stated:

[I]t seems clear that FBAR [penalties are] encompassed by the Court’s sweeping ruling (particularly as [the holding]  fits with the discussion in the previous Section 7623(b)(5) case, as well as the reference in footnote 15 in this case to Hom – and citing that FBAR is “tax administration”).

Our readers and tax procedure enthusiasts are likely familiar with Mr. Hom.  His cases have graced our pages somewhat frequently, most recently in late July with the Ninth Circuit holding online gambling site accounts were not subject to FBAR disclosure (well done Joe DiRuzzo).  Les had a brief write up on that found here. The footnote Dean references cites to a different Hom case in the Ninth Circuit from this year, and the note states:

Ours is not the only court to note that tax laws and related laws may be found beyond those codified in title 26. The District Court for the Northern District of California in Hom v. United States, 2013 WL 5442960 … aff’d, … 2016 WL 1161577 (9th Cir. Mar. 24, 2016), stated: “[T]he issue here is whether [31 U.S.C.] Section 5314 is either an internal revenue law or related statute (either designation would make the disclosure [of taxpayer information under sec. 6103] permissible). The United States argues that [31 U.S.C.] Section 5314 is a ‘related statute’ under Section 6103 (Dkt. No. 13 at 6). This is correct. Congress intended for [31 U.S.C.] Section 5314 to fall under ‘tax administration.’”

Hammering home that FBAR penalties are likely included in “collected proceeds”.

Dean also addressed the Chevron comment from my post regarding the regulations that were not before the Tax Court case.  I highlighted (because Les pointed it out to me) that the Tax Court’s language was akin to language used when tossing a regulation under Chevron.  Dean agreed, and provided additional insight:

The language used by the Tax Court – plain language and enforce the terms – is, as you know, right in step with the language we see from Courts when they are rejecting agency regulations under Chevron.    While the Regulations are not at issue here – see footnote 9 – it is difficult to imagine the Regulations withstanding a challenge given this holding.  However, the real hope is that the administration will not appeal the decision and seize the ruling as a chance to make the correct policy decision (as you note) and embrace the commonsense decision by the Court on defining collected proceeds broadly.

Footnote 9, for those of you interested, states both parties agree the regulations are not at issue, as the decision regarding the award was rendered prior to the effective date of the regulations.

Many thanks to Dean for his comments on the case, and congratulations on a great result.

Administrative Law Grab Bag: Chevron and State Farm Developments

Last week’s post Treasury on the Right Side of the APA in Altera highlighted the importance of administrative law generally as well as some landmark cases such as Chevron and State Farm. In today’s post I offer some general developments on both Chevron and State Farm, one in the form of proposed legislation that if enacted would overrule Chevron and shift the power to interpret statutes from agencies to courts. The other is a Supreme Court decision from late June that elaborated on State Farm in a way that may have specific relevance for challenges to Treasury regulations when parties allege that Treasury has failed to adequately explain its reasons for promulgating regulations.

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First some background. As most tax people know in the post-Mayo world, Chevron provides a two-step inquiry for reviewing agency interpretations of statutes that is easy to state but challenging to apply. Under Chevron the court first (under Step 1) determines if Congress directly spoke to the question at issue. If a court finds that Congress did, then the court defers to the statute and the agency’s interpretation falls if it is inconsistent with the statutory language. If Congress did not address the issue in question in the statute itself or if the language is ambiguous then the inquiry (under Step 2) is whether the agency’s answer is based on a “permissible” construction of the statute. A permissible construction is one that is not “arbitrary, capricious, or manifestly contrary to the statute.” If it is permissible then the court defers to the agency.

In PT we have also discussed principles relating to State Farm, issues that are front and center in the Altera dispute. As Pat Smith discussed for us in his post discussing the IRS’s Altera defeat, “[u]nder the Supreme Court’s landmark 1983 State Farm decision, in order for agency action to satisfy the arbitrary and capricious standard, the agency action must be the product of “reasoned decision-making,” and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”

Proposed Legislation on Chevron

Last week the House passed the Separation of Powers Restoration Act, a bill that if enacted would overturn Chevron and amend the APA to provide that courts review “de novo all relevant questions of law, including the interpretation of constitutional and statutory provisions and rules.” The legislation is the product of efforts of the Article I Project, a network of House and Senate legislators that describes itself as working on a “new agenda of government reform and congressional rehabilitation.” The Article I Project Web Page states that its mission is to “develop, advance, and ultimately enact an agenda of structural reforms to strengthen Congress by reclaiming its constitutional legislative powers that today are being improperly exercised by the Executive Branch.”

Republican Congressman John Ratcliffe of Texas is the sponsor of the legislation in the House. He has a post in the Hill Separation of Powers Restoration Act Key to Rebalancing Government describing the legislation:

This critical measure reverses the 1984 Supreme Court decision that established the “Chevron doctrine,” placing the power to determine ambiguous laws back into the hands of the Judiciary. This would help stop future abuse of power by preventing administrative agencies from establishing regulations with the intent of leveraging the “Chevron doctrine” to implement them however they so choose, fully free from judicial review. Instead, agencies will be forced to adhere to the courts’ interpretation of the laws they implement – keeping them from “grading their own papers,” as they’re allowed under the “Chevron doctrine.”

There is also a Senate version of the bill (co-sponsored by Senators Hatch, Lee and Grassley) though that has yet to move out of committee. An article in the Dallas Morning News indicates that the President would veto this bill if it came to his desk.

Does Chevron Make a Difference?

Does Chevron deference make a difference in agency outcomes in court? In a working paper called Chevron Deference and the Courts Professor Kent Barnett of University of Georgia Law School and Professor (and former PT guest blogger) Christopher Walker from Ohio State Moritz College of Law suggest that it does. They looked at every published decision citing Chevron in a ten year period and “found that the circuit courts overall upheld 71% of interpretations and applied Chevron deference 75% of the time. But there was nearly a twenty-five percentage-point difference in agency-win rates when the circuit courts applied Chevron deference than when they did not.”

The study found differences across circuits and a difference between Supreme Court and circuit court outcomes, with the authors concluding that Chevron may not have as much of an effect on agency outcomes at the Supreme Court but that it may be “an effective tool to supervise lower courts’ review of agency statutory interpretations.”

Supreme Court Developments on State Farm

So while there are some rumblings in Congress to overturn Chevron, there are some preliminary questions that arise before one gets into the Chevron inquiry. For example, what has been called Chevron Step Zero asks whether Congress intended to defer to agencies in the first place. To that end if issues implicated are extraordinary and of great importance, as in King v Burwell last year (involving the IRS’s regulatory definition of exchanges for purposes of tax credits), the courts may conclude that the issue is one that Congress did not intend for agencies to play a role in filling statutory gaps. The upshot in those cases is that courts take a de novo crack at the statute in the manner that the Separation of Powers Act legislation proposes.

Another of those preliminary questions presents itself in the Supreme Court case Encino Motorcars v Navarro, decided this past June. Bloggers and law profs Michael Pollock and Daniel Hemel at the Notice & Comment blog discuss the Encino Motorcar case and its relationship to general administrative law principles in the post Chevron Step .5 Their post is terrific. I highly recommend that readers with an interest in the area read the whole post, though I hit some of the high points here.

The Encino case involved Labor Department rules that provided that service employees at car dealers were entitled to overtime pay. The service employees sued the car dealers asking for overtime; the dealers claimed that Department of Labor failed to adequately explain why it changed its mind and promulgated rules that said that service employees at car dealers were not exempt from overtime pay (a statute exempts overtime for “any salesman, partsman, or mechanic primarily engaged in selling or servicing automobiles, trucks, or farm implements, if he is employed by a nonmanufacturing establishment primarily engaged in the business of selling such vehicles or implements to ultimate purchasers.”). The Labor Department had gone back and forth on the issue for decades and in 2011 took the view that service employees were not exempt from overtime.

The 9th Circuit applied a traditional two step Chevron inquiry and found that the statute was ambiguous (Step 1) and the agency’s interpretation was reasonable (Step 2). In Encino Motorcars the Supreme Court stated that the Labor Department failed to explain its reasons in coming up with its 2011 rules, remanding the case back to the 9th Circuit to interpret the statute:

One of the basic procedural requirements of administrative rulemaking is that an agency must give adequate reasons for its decisions. The agency “must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U. S. 29, 43 (1983) . . . .

Applying those principles here, the unavoidable conclusion is that the 2011 regulation was issued without the reasoned explanation that was required in light of the Department’s change in position and the significant reliance interests involved. In promulgating the 2011 regulation, the Department offered barely any explanation. . . . This lack of reasoned explication for a regulation that is inconsistent with the Department’s longstanding earlier position results in a rule that cannot carry the force of law. See 5 U.S.C. § 706(2)(A); State Farm, supra, at 42-43. It follows that this regulation does not receive Chevron deference in the interpretation of the relevant statute.

How does this relate to Chevron and State Farm? Using a helpful example, bloggers Pollock and Hemel suggest that there is a preliminary step that arises prior to the two-step Chevron test and after Step Zero, a Chevron “.5” step:

To put the point starkly, imagine an agency had been granted the authority to engage in notice-and-comment rulemaking and wrote a new regulation (on a matter within its jurisdiction and expertise) on the back of a napkin nailed to a signpost outside the White House. The regulation contains an interpretation of an ambiguous statutory provision, again within the agency’s jurisdiction. If that agency then claimed its interpretation written on that napkin was entitled to Chevron deference, it would (we think) be laughed out of court. But why? Congress intended for the agency to fill gaps in the statute (Chevron step zero) and the statute is indeed ambiguous (Chevron step one). Suppose, too, that the interpretation adopted by the agency on the napkin is entirely reasonable (indeed, maybe even the best reading of the statute), and that the agency actually explained its reasoning quite thoroughly despite the napkin’s surface-area limits. So the interpretation should pass muster at Chevron step two—and would even satisfy State Farm’s reason-giving requirement. But no one (we don’t think) believes that an agency can get Chevron deference for a position taken on a napkin. Why not? Because the agency failed to follow the proper procedure for exercising its gap-filling authority. The napkin rule flunks at Chevron step 0.5.

The post goes on to explain why it is likely that winning a Step .5 challenge does not automatically result in a victory, as agency interpretations will still be given heightened (though not quite Chevron) deference under Skidmore, where the weight of an agency interpretation “depend[s] upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.” Skidmore, 323 U.S. 134, 140 (1944)).

Moreover, using some administrative law acrobatics, the post explains why in many other challenges involving a party bringing an action against an agency (except tax cases), courts generally resolve procedural defects such not under this type of Step .5 analysis but under the APA itself.

Some Parting Thoughts

A decade or so ago there were only a handful of tax cases that leaned on administrative law principles. Now, litigants look to administrative law and its complexities as a principal means of attacking IRS and Treasury actions. No doubt that Treasury and IRS are deeply aware of the administrative law sharks circling agency actions; the extensive discussion of comments in the preamble to Treasury’s recently promulgated regulations under Section 7602 addressing the use of private contractors to assist in interviewing summoned witnesses reflects that sensitivity (note Keith commented on those regs last week in Tax Notes; a free link is not available).

With Altera and other cases teeing up an application of some basic administrative law principles in the tax context, and many other cases in the pipeline where litigants are looking to administrative law principles to challenge IRS rulemaking and other practices we will likely see many more cases and posts in PT struggling to come to terms with how tax cases fit in with the many nuances of administrative law.

UPDATE 7.18 10:30 PM: Florida State’s Steve Johnson has written a taxprof blog Op-Ed on the proposed legislation. It raises some questions in the event of passage (unlikely at least for now as Steve acknowledges) and is full of good references to other works and Steve’s prolific writings on Chevron and related topics over the years. It does a nice job as well situating Steve’s support for dispensing with Chevron.